VTRU - Vitru Grows Market But Returns Remain Muted

2023-12-28 14:43:18 ET

Summary

• Vitru Limited provides distance education courses in Brazil and has a hybrid approach combining online courses with periodic in-person meetings.
• The company has a broad footprint with over 2,400 hubs in Brazil and operates in a large and distributed market.
• While Vitru has made acquisitions and grown revenue and operating income, there are risks including ongoing long-term currency depreciation and political volatility in Brazil.
• My discounted cash flow analysis indicates the stock may be fully valued at its present level, so I'm on Hold for Vitru Limited shares.

Investment Outlook

Vitru Limited ( VTRU ) provides distance education courses to adult students in Brazil via its platform.

The company went public in 2020, and I rated the IPO a Hold due to slow revenue growth at the time and the onset of the pandemic.

While VTRU has made significant acquisitions in adjacent markets, expanding its revenue base, its return on equity has flatlined, and the company faces political and long-term currency depreciation risks against the U.S. dollar.

Also, my discounted cash flow calculation suggests Vitru Limited stock may be fully valued at its present level, so my outlook on VTRU in the near term is a Hold.

Vitru’s Approach and Market

The company has adopted a hybrid approach to providing distance/virtual learning for post-secondary students located in various provinces in Brazil.

This approach, which features a combination of online courses and periodic in-person meetings with teachers, has become popular for otherwise virtual education providers.

The reason is that without in-person check-ins, virtual-only students tend to have worse retention and lower graduation rates.

So, businesses like Vitru use this hybrid model, which costs more than a virtual-only model, to keep their students for longer and produce better educational outcomes which helps to attract other fee-paying students.

Vitru operates more than 2,400 hubs in over 1,400 cities in Brazil. Many of these cities only have one brand that Vitru operates, so the company has a broad footprint.

According to a 2019 market research report by Privacy Shield, the education industry size in Brazil was an estimated $12 billion in 2018, with 57 million students enrolled in that year.

Approximately 72% of higher education students go to private institutions which tend to charge many multiples of the average annual working salary for tuition.

The chart below shows the trend toward higher education enrollment in Brazil through 2018:

There are federal student loan programs that provide certain incentives to private institutions to offer tuition assistance to students from low-income households.

Essentially, these are subsidies to the private companies to widen their footprint, which would otherwise be focused on only the higher-level economic strata in Brazil and among regions within the country.

Financial Trends And Valuation

The company's revenue and operating income growth has been impressive, although it has been partially due to its merger with Unicesumar for $662 million in May 2022.

Unicesumar was an online learning site focused on the medical education industry in Brazil, so the expansion was into an adjacent market that makes sense.

Gross profit margin by quarter (green line) has been flat recently, but has improved markedly since the company's IPO in 2020, when margins were in the mid-50s.

Vitru’s SG&A expenses as a percentage of total revenue by quarter (amber line) have varied within a narrow range in recent quarters as the company’s business is cyclical/seasonal throughout the year, and fluctuations are considered normal by management.

(All data in the above charts is GAAP.)

The graphic below is a discounted cash flow calculation using my assumptions about forward organic growth rate and earnings per share:

My discounted cash flow ("DCF") analysis indicates that the stock price is fully valued at its current level of around $16.00, assuming a forward earnings per share estimate of $2.31 and organic earnings growth of 5% over the next ten years.

The model is highly sensitive to forward growth rate, so if earnings growth turns out to be higher by even one percentage point, the stock may be undervalued at its current level of around $16.00.

Commentary On Vitru’s Prospects

Since its IPO in 2020, Vitru has successfully navigated a difficult pandemic period and made transformative acquisitions to expand its total addressable market, so management has performed well in that regard.

However, its return on equity has essentially flatlined on an annual basis in the last few years, as the chart shows here:

This indicates to me that while the firm has enlarged its operational footprint and expanded its addressable market, it hasn’t improved its equity shareholder return in any meaningful way.

With SG&A costs varying within a range and with no discernible trend along with management’s comments, it appears that underlying student acquisition costs are relatively stable.

In addition, the company has improved its accounts receivable collection efforts and has experienced a slight improvement in macro conditions, so cash conversion appears to be strong.

The most recent cash flow from operations was a nine-quarter high of $49.2 million, indicating definite improvement in this critical area.

Also critical is its ability to leverage its existing Hub footprint and to rein in costs. Management views its hub "maturation" level as 43%, indicating it believes it can more than double the number of students it serves from its existing hub capacity.

However, this is an overall metric and doesn’t take into account the fact that some hubs would likely be at capacity and other hubs underutilized, necessitating additional hub creation along with those related expenses.

One ongoing problem with Brazil-based companies for U.S. investors is the continuing trend of the drop of the Brazilian Real against the U.S. dollar.

While the Real has strengthened in recent quarters, the continuing trend is downward, as the five-year chart shows here:

The chart indicates a roughly 25% currency valuation drop against the U.S. dollar over the last five years, which means that a Brazilian company like Vitru would have to increase its earnings or free cash flow by that amount just to ‘stay even’ when analyzed in U.S. dollar terms.

Another uncertainty is that of Brazilian political volatility. The country has lurched right and left in recent years, creating a pendulum effect of uncertainty among investors as to government policies regarding education and private institutions.

While it’s hard to quantify such developments, they generally do not lend themselves to stability, which is an ideal condition for business planning and growth.

Management has done well in navigating changing economic, political and company transformation conditions but needs to show improvement in earnings to justify a higher valuation.

So, I’m on Hold for Vitru Limited shares for now.

For further details see: